Hillary Clinton last week announced her plans to deal with a major election issue in the US – the record-breaking level of student loan debt. Her plan, called the New College Compact, is an effort to eliminate the need for students at publicly-funded colleges and universities to borrow to pay tuition and to reduce the burden faced by those already repaying their student loans.

Would this plan work in Canada? Let’s consider two of the major proposals in the Clinton plan.

Grants from the federal government to the states, conditional on eliminating the need to borrow

Under the plan, the US federal government would offer large grants to US states on the condition that they take action to make sure that students do not need to borrow to pay the tuition charged by public post-secondary schools. The states would do this by offering money to their public universities on the condition that they reduce tuition fees enough so that students do not need to borrow to pay them. What the states could not do is reduce state spending on public post-secondary education.

The “debt-free tuition” promised by the Clinton plan is far from a “free college education.” If students want to live on campus, they will have to pay more for room and board than they otherwise would and they might have to borrow to pay those incremental costs. And “debt-free tuition” does not affect the main economic cost of college — the earnings foregone while in school.

What about post-secondary access for low-income students? Students from low-income families already have “debt-free tuition”; Pell grants from the US federal government are enough to cover their tuition.[1] But such students would still be helped by the new plan. Because the states will not be allowed to “count” federal grants to students in their plans to establish debt-free tuition, students from low-income families will not have to use their Pell grants to pay tuition and can instead use them for living expenses.

This sort of cash transfer from the federal level to the provincial level has a long history in Canada. We call it the “federal spending power”. In areas that are acknowledged to be under provincial jurisdiction — health, education, social assistance — the federal government provides cash transfers as long as the provinces agree to minimal conditions. Money flowed to the provinces for post-secondary education under Established Program Financing from 1977 to 1995, under the Canada Health and Social Transfer (CHST) from 1995 to 2004 and, since then, under the Canada Social Transfer.

The major difference between the existing Canadian federal-provincial grants and those envisioned under Clinton’s New College Compact lies in the degree of accountability required. While the Canadian government specifies a “notional allocation” of the CST, suggesting that one-third be spent on post-secondary education, there is no requirement that provinces accept those notions; they can spend the cash on any part of their post-secondary system. The Clinton plan would have more specific conditions, all aimed at ensuring that students at public universities would not have to borrow in order to pay tuition.[2]

The use of the Federal spending power has been enormously controversial in Canada, even with relatively few conditions imposed on the cash transfer. The cash transfers are seen as an overt effort by the federal government to insert itself into areas of provincial jurisdiction. To impose more specific conditions – one example would be requiring that the provinces use the money to substitute grants for the 40 percent of assessed need now met by provincial loans — would doubtless be met with concerted opposition from the provinces.

The provinces are already taking action on their own to deal with the growth in student loan debt. Ontario has a program that limits the maximum amount that each student must borrow each year — any annual borrowing in excess of $7,400 is repaid by a provincial grant. More dramatically, Newfoundland and Labrador has eliminated its provincial student loan program, replacing the loans with grants.

Lowering the interest rates charged on government student loans

A second important component of the Clinton plan is to reduce the interest rates charged on existing student loans. When first proposed in 2014 by Senator Elizabeth Warren, the idea was to make it possible for former students to renegotiate the terms under which they were repaying their student loans, lowering their interest rates to the 3.86% level charged on 2013-2014 government-subsidized loans to undergraduate borrowers.[3] The Clinton plan also proposes to allow borrowers in repayment to renegotiate the fixed rate they were initially charged so that they pay the lower current interest rate.

For no discernible reason, Canadian student loan borrowers face interest rates on their federal loans that are higher than their US counterparts. Since 1995, Canadian borrowers starting repayment have had two choices regarding the interest rate they will be charged: (1) a fixed rate, determined as the prime rate in force when repayment starts, plus 5.0 percentage points; or (2) a variable rate determined as the prime rate in each month plus 2.5 percentage points. Almost all borrowers choose the second option.

At the moment, with the Canadian prime rate at 2.7%, the variable rate on federal student loans is 5.2%, higher than the current US rate for undergraduates of 4.29%. The Table below shows the US and Canadian rates over the past ten years.

Interest Rates on Student Loans in the US and Canada

(1)

(2)

(3)

(4)

Academic Year

Loan rate in Canada

Loan rate in the US

Difference in rates

2006

8.50

6.80

1.70

2007

8.50

6.80

2.70

2008

6.00

6.00

0.00

2009

4.75

5.60

-0.85

2010

5.50

4.50

1.00

2011

5.50

3.40

2.10

2012

5.50

3.40

2.10

2013

5.50

3.86

1.64

2014

5.50

4.66

0.84

Current

5.20

4.29

0.91

Sources: Column (2) The variable rate charged on federal student loans in Canada is the prime rate plus 2.5 percentage points. The rate in the table above is calculated using the December “prime business rate” reported by the Bank of Canada. The Canada Student Loans Program calculates the prime rate to be used for its loans from the rates reported by five major chartered banks; it drops the highest and lowest rates and averages the remaining three. Column (3) is drawn from Smole (2013) and from the US Department of Education and is the rate charged on subsidized Stafford Loans to undergraduate students.

Because the US government currently makes money on student loans — $66 billion on loans issued between 2007 and 2012, according a Government Accountability Office (GAO) report — and would lose that source of revenue, both Senator Warren and candidate Clinton proposed ways to make up lost revenue. Warren would have financed her plan by imposing a minimum tax on high earners; the Clinton plan would be financed by limiting the tax deductions claimed by high-income taxpayers.

The gap in rates suggests that the Canadian federal government is making money on its student loan portfolio but no calculation has been made public.[4] Lowering the rates paid by both past and present student loan borrowers is clearly possible — the provinces have already done it. All the federal government has to do is give up the profits from the business of lending money, at interest to students.[5]

Notes

[1] The College Board publishes information on the net prices faced by students in different kinds of post-secondary institutions. The 2014 edition of their Trends in College Pricing reports (p.25) that “On average, in 2011-12, full-time in-state students at public four-year universities from families with incomes below $30,000 received enough grant aid to cover tuition and fees and have about $2,320 left to put toward room, board, and other expenses.”

[2] In particular, the Clinton plan would “[p]rovide incentive grants to states that commit to ensuring that no student should borrow for tuition and improved affordability for other costs at 4-year public colleges and universities. States will have to halt disinvestment in higher education, ramp up that investment over time, and work with public colleges and universities to cut costs and increase innovation.”

[3] For a review of the contentious debate about the rate of interest charged on US student loans, see Smole (2013).

[4] The profit that the government might make on student loans is a function of many variables other than the interest rate charged. These other variables include, for example, the expected default rate and the level of administrative costs. Indeed, the “headline” of the GAO report is that interest rates cannot be set to ensure that revenues exactly cover costs.

[5] One concern about allowing former students to renegotiate their student loan interest rates is that many of those who would benefit are high income people. For example, law students and medical students face very high tuition fees and generally borrow the maximum available from government-subsidized loan programs. The same is true for US students who attend private colleges, borrow large amounts and then find high-paying jobs. Will these kinds of former students, who are not in dire need of interest relief, benefit disproportionately? For me, this is an empirical issue. Many such people will have already borrowed from other sources (e.g., lines of credit) and repaid their high interest student loans. A tabulation of borrowers in repayment, by level of earnings, would reveal how the benefits of interest reduction will distributed.